The world of gold about to change?

When you look at the price of gold in 2016 you see that the level we have today 1130 USD/oz is only a little bit higher than January’s 1050 USD/oz. Jumping to conclusions we may say that this year was very calm but the reality is far from it.

An analysis based primarily on the price of metal is misleading. Last 12 months were chaotic and official price of gold seems to obscure the shift this market is experiencing.

Gold opens new doors

According to the news from 2 weeks ago, gold will be accepted as an investment asset in the Middle East. The decision made by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) will increase bullion demand.

The Muslim world has higher standards than Comex and will not accept certificates without backing in physical metal – paper gold. Comex binges on paper gold making them an unlikely candidate for cooperation.

The fate of the SPDR Gold Trust is on the line. Popular GLD fund is fully backed by physical metal but redemption (receiving physical metal) was available only for JP Morgan lately. If SPDR Gold Trust fails to prove it is able to supply any amount of metal to every financial institution it will be written off, just like Comex.

How much money are we talking about? The Islamic investment market for gold is worth 1.8 trillion USD. Note that Eastern approach to investment is different from Western style. Both Europe and America got used to futures and use only certificates in trade. The culture from the East demands metal – not paper. Investors fly to Dubai to purchase physical bullion. Many will call this being backward-looking or medieval but with the market’s situation today it looks to me as a common sense.

SGE is rising

I mentioned Dubai on purpose. The exchange there recently informed that they will use the price of gold given by the Shanghai Gold Exchange. This is a historical moment as we see Chinese power growing each year similarly to the total trading volume.

During last 36 months, trading volume of SGE increased five-fold. We cannot be fooled reading about huge Comex’s volumes. If we inspect a number of actual gold deliveries, Shanghai is 44 bigger compared to New York.

Not that long ago prices of gold in the US and China started to vary considerably. Price in China is now 30-40 USD over the price in New York. The trend is strengthening – premium in China is developing. Given that this difference will continue we will see arbitrage. What is arbitrage? Major institutions will conclude that it is worth to buy metal cheaply in the US and sell it with premium in Shanghai. “We just bought gold for 1100 USD and we see you are selling for 1200 USD, how about buying gold from us for 1080?” This way prices of two markets will slowly converge but it is unlikely it will reach the exact same level. These two prices – Western and Eastern – are becoming an intrinsic element of the financial picture. Result? Comex may be drained from the metal.

There is also a possibility that the difference between prices is going to be so big that Comex will suspend trading and settle contracts with the last price.

Two prices of gold?

Last weeks, Chinese authorities introduced restrictions on gold imports. Today, only dozen of banks and financial institutions can legally get the gold into the People’s Republic. It is suspected that those regulations may have caused price differentiation between gold in America and in China.

If you were worried that soon there will not be enough gold in the West, you can rest assured that there is enough of it. In the chart below you can see confirmation in the levels of premium the Sprott fund receives over the Comex’s price of gold.

Source: sprottphysicalbullion.com

In 2011 acquiring big amounts of physical gold was very hard. Investors were keen on paying even >20% more than Comex’s price only to buy the fund 100% covered in metal.

Summary

It does not matter how big manipulations are in the precious metal market because, after all, the market always returns to reality. The best example is how two prices of gold emerged – we were warning against it a few years ago. This may be the last warning to finally leave paper certificates and move into a trade based on physical metal.

The situation in the market is also a sociological example, showing differences between the philosophy of the East and the West. However big market manipulations are in gold and silver trade, Western investors seem to still believe paper certificates. On the contrary, the East is using common sense and accumulate physical wealth.